The Unintended Consequences from Government Actions Leading
to Currency Wars: A Multiple Case Study
Dr. Craig Martin, University of Phoenix, Northcentral University, Walden University, USA
ABSTRACT
Although the actions initiated by Governments and Central Banks are intended to produce positive
outcomes for the host country, financial implications for markets and the macro economy often produce uncertainty
and detrimental consequences for consumers and investors alike. Using a foundation of Systems Theory and
Complexity Theory, the multiple case study conducted sought to further understanding about why these unintended
factors arise and to explore how financial risk for investors emanating from the uncertain future of a currency war
may be mitigated. The research suggests that market volatility during and post the currency war is expected, that
inflation and/or deflation will arise and that upheaval of the system of global currencies occurs as a result of the
currency wars. By furthering understanding about the derivation of these economic consequences, long-term,
retirement-planning investors can manage portfolio asset diversity to mitigate risk for expected returns on
investment.
INTRODUCTION
Although international currency wars have proven to produce one of the most destructive set of outcomes,
the Government actions leading to a currency war do not occur for the purpose of initiating economic conflicts
(Rickards, 2011). Central Governments seek full employment for national constituents; economic theory has posited
that employment growth follows from growth in production of goods and services (GNP). Growth in exports
contribute positively to GNP growth and Governments employ fiscal and monetary policy to achieve growth in
exports (Hill, 2013).
Unintended consequences from the Government actions to foster growth in trade have ranged from the theft
of market share in exports from trading partners and the resultant retaliation by those partners to sequential bouts of
inflation and deflation and recession to collapse of currency systems. Such are the outcomes from the currency wars
from the twentieth and twenty first centuries (Rickards, 2011).
While the research suggests that unintended consequences in aggregate are predictable as outcomes from
currency wars, the specifics of these occurrences are not predictive. The resultant uncertainty promises an
environment that does not suit the long-term, retirement-planning investor whose proclivity is to seek a return
certain on one’s investments (Dent, 2014). However, if the investor understands the likely boundaries of outcomes
for values of paper currencies operating in context of economic currency wars, said investor should be able to
rationally plan a diversified portfolio that mitigates risk to the potential return on investment (Taleb, 2012).
LITERATURE REVIEW
The review of literature will explore the operating factors resulting from Government actions found in the
three international currency wars occurring since the early 1900s. Literature reviewing how the investor is
influenced by economic outcomes to currency wars and Governmental tactics taken to combat said wars will be
considered. Foundational theories of risk and uncertainty, regarding systems theory applied to economics and about
use of complexity theory to explain factors and behavior found in complex systems will be explored.
Currency Wars as a Phenomena
There have been three economic, global currency wars since the early 1900s (Rickards, 2011). The first
arose after the end of World War I (WWI), commencing in 1921 as Germany sought to develop a plan to satisfy
requirements of War reparations dictated unilaterally by the Allies at the Treaty of Versailles and ending in 1936 as
the World moved toward military confrontations. The second currency war began in 1967 with the attacks by
speculators on the value of Sterling, ending in 1987 as the US dollar was bolstered in value as a result of the Plaza
Accord. Currency War number three, featuring the dollar, the euro and the Yuan, is precipitated by the Federal
Reserves’ Quantitative Easing Program, officially began in 2010 and as yet has not reached a conclusion.
Central Governments have a primary objective to achieve full employment for its citizens who want to
work to provide for one’s family (Ohmae, 2005). Citizens able to satisfy microeconomic needs peacefully have no
reasons to pursue policies to extract needed goods from country neighbors and/or to seek a new Government through
revolution (Sowell, 2004). In the early 1900’s, Western Central Governments adopted concepts introduced by Karl
Marx (1992) and John Maynard Keynes (1965) to actively foster macroeconomic growth, which was thought to be
correlated to achievement of full employment.
The United States (US) Government and the Federal Reserve, as well as other Governments and other
Central Banks, have been primary agents for actions taken that led ultimately to the formation of an economic
currency war (Stockman, 2013). Germany in 1921 purposefully devalued the Mark post WWI in order to enhance
the exports of chemicals to raise hard currency to pay reparations dictated by the Treaty of Versailles, led primarily
by France and England and to a lesser degree by the United States. The German action alone likely would not have
led to currency war; however after the 1928 stock market collapse, both the US and France inflated-devalued- their
own paper currencies by straying from the quasi gold standard agreed to as part of Treaty of Versailles (Rickards,
2011). Shortly thereafter, Great Britain released the British Pound from the silver standard in order to continue to
compete in the France-Great Britain-USA trade triangle. As the Gross National Product (GNP) of England and the
US continued to fall and deflation appeared, President Roosevelt introduced tariffs to make popular imports more
expensive, confiscated US gold held by citizens and devalued the paper dollar further by buying gold on the British
currency exchange. World War Two (WWII), and not the cumulative actions by the Governments of Germany,
France, Great Britain and the US, enabled the Countries to escape the outcomes of the first currency war (Hill,
2013).
The formation of a gold exchange standard for the World’s dominant currencies at Bretton Woods in 1944
enabled a stable currency system for trade until the late 1960s (Eisen, 2013). During that period, the US dollar
evolved as a reserve currency serving alongside the British Pound Sterling. With the decline of the British economy
relative to global economic leaders and with the US economy over-burdened with President Johnson’s “guns and
butter” policy for supporting the Viet Nam War and the US consumer, speculators began to attack first the value of
the Pound relative to Sterling in 1967 and subsequently the value of the dollar relative to gold. In 1971, President
Nixon devalued the currency indirectly by ending the gold exchange privilege for the dollar, effectively establishing
the floating currency system that remains in existence in 2015. The devaluation set the stage for the second currency
war of the 20th century, which lasted until 1987 (Rickards, 2011). The primary Governments involved in this second
currency war included the major developed countries of Europe – West Germany, Italy, France, England – and the
US and Japan. During much of the 20 year period 1967 – 1987, the United States experienced inflation and low,
stagnant growth in GNP. Japan and the Western European countries economically grew during the period as the US
shifted from a leader in net exports to a leading net imports nation (Stockman, 2013).
Currency War III began in 2010 when the Federal Reserve Bank in the United States began its quantitative
easing program established to enact monetary policy established by the Government (Rickards, 2011). The intent of
the monetary policy, which ended in 2014, was to influence indirectly the reduction in long term US interest rates to
accompany the short-term rate US reductions directly influenced by Federal Reserve interbank rate policies
(Lowenstein, 2011). Driving interest rates down toward zero enacts a reduction in periodic interest payments due to
other countries and in real value of dollar denominated debt owed to other countries – primarily England and the
Republic of China (China). The reduction in interest rates also influences the relative value of the dollar downward
(devaluation of dollar) versus those countries with relatively higher long-term interest rates for national securities.
Devaluation of a currency favors exports and inhibits imports for the country undergoing devaluation of its currency
(Appleyard and Field, 2014).
The above actions have not gone unnoticed by the euro currency countries (primarily Germany, France and
Italy), Japan and (China), who are major trading partners with US. Along with England, each of these Governments
are engaged making decisions which intent are to counteract effectively the monetary moves fostered by the US.
Although the latest war is still in progress, outcomes visible are reductions in growth in GNP in Japan, China and
most of the European Union, and very slow growth (1.5-2.0%) in the United States (Rickards, 2014). Due to Central
Bank actions, inflation in China has slowed; however there are signs of deflation occurring in European Union and
in United States (Dent, 2014).
Currency Wars and the US Investor
The United States investor, whose plan is to invest in securities to plan for retirement, considered in the
research is the person with a long-term objective for return earned on one’s invested monies in open securities
markets (Dent, 2014). Many of these investors include 401-k and similar tax advantaged plans as an effective
platform for maximizing the earned return on investment sought through the practice of compounding interest,
dividends and growth in principle in order to effectively grow one’s portfolio (Dent, 2014).
Factors of importance to the long-term, retirement planning investor include the risk inherent in investment,
which is manageable (Fox, 2009), and uncertainty about probable outcomes present in future periods, which is not
manageable but can be mitigated by application of statistics and Systems and Complexity Theory (Taleb, 2010).
Investors balance the potential risk of loss of principle value for any investment made and the potential gain possible
from the invested capital.
The value of investments in securities are influenced by financial factors of companies and mutual funds
present in organizations which issued the securities (Dent, 2014). The value of the securities are also related to
overall value of the securities market in which traded (Brealey and Myers, 2003). Government, including directed
Central Bank, actions influence the value of investment markets directly and indirectly the values of one’s
investments (Lowenstein, 2011). The Government actions with which this research is concerned include those made
following fiscal and monetary policies.
Fiscal policy may influences securities markets, and thus the investor, in two ways. If the Government
spending incorporates construction or development, the spending translates to growth in GNP which is a positive
influence on growth in equity securities markets (Fox, 2009). If that spending requires an increase in Government
debt, the resultant debt increase may lead to an interest rate increase for the Government debt and a corresponding
decrease in current value of debt instrument (Fox, 2009). However, Government spending has been shown to
provide a future return in GNP growth of less than one dollar ($.94) for every dollar spent while private investment
returns about $7 dollars in the future for each dollar invested (Sowell, 2010).
Monetary policy may influence securities markets positively or negatively depending on the policy applied
(Thornton, 2012). The Federal Reserve is the agent for enacting Governmental monetary policy in the US. The
Federal Reserve is charged following the Full Employment Act of 1978 (Humphrey-Hawkins Act) to balance US
employment and price stability in enacting monetary policy. In actual practice the Federal Reserve seeks to balance
growth in GNP and price stability, although research in 1968 by Friedman and Phelps demonstrated no clear
relationship between employment and unemployment rate and GNP growth (Thornton, 2012).
Systems and Complexity Theory
Systems thinking enables one to consider a structure or event as a whole rather than consideration of a set
of linear components or actions (Gharajrdaghi & Ackoff, 1985). A system is defined as a whole that is both greater
than and different from its parts. A principle of systems thinking is that the understanding of behavior within a
system can’t be advanced by analysis conducted of its components or elements. System behavior is posited to be a
function of the whole rather than to be influenced independently by any one part of the system.
Systems theory is used to understand the boundaries of a holistic system and, once the boundaries are
known, to advance understanding about the interrelationships existing between entire systems (Wallerstein, 2011).
The theory has been applied to systems that nest one within another in order to understand entire societies and even
the World as a whole.
Patton (2015) has been a leader in use of systems theory for the study of behavior found in economic
systems, real-world markets and within the real-world intersections and interrelationships found between horizontal
systems and nested systems. Patton (2015) notes that employing a systems orientation can be of assistance in
framing questions of exploratory inquiry and, later, in advancement of understanding from the data collected using
qualitative inquiry.
Melanie Mitchell (2009) defines a complex system as a large network of components with no central
control and simple rules of operation, which give rise to unpredictable collective behavior, sophisticated information
processing and learning by the system through adaptation and /or evolution. Patton (2015) posits that the flexibility,
openness and adaptability found in qualitative inquiry enables the use of complexity theory as a framework for
qualitative research –inquiry – for the understanding of behavior in complex, dynamic situations and phenomena. A
phenomena for which the application of complexity theory has proved especially useful to advance understanding
include world securities markets and Governmental macroeconomic applications of monetary policy (Taleb, 2012).
METHODOLOGY
Research was conducted using a design of multiple case study (Yin, 2014). The boundaries adopted for
each case are the primary countries taking actions contributing to a respective currency war and the years in which
outcomes for the securities markets influenced by these actions were unexpected and unintended (Rickards, 2014).
Each of the three currency wars described above is considered in context of a case.
As the currency wars studied extend over 90 years and the third, current war is yet to reach conclusion, the
source of data for the research are texts and journal articles found in business libraries and data bases. Document
analysis and content analysis, each employing the principle of triangulation for data collection, are tools described as
specifically effective in Case Study for data collection and analysis (Yin, 2014). Triangulation of data retrieved from
the authors, who are experts in analysis of securities markets and the factors influencing market performance, was
the strategy employed to achieve credible analysis (Patton, 2015).
The foundational framework employed for the multiple case studies includes systems theory and
complexity theory to seek understanding of behavior found to be operational in the US economy and the National
securities markets of the United States. Complexity Theory will be used to advance understanding about
interrelationships which emerge between the actions of the US Government and it central bank, the Federal Reserve,
and the resulting outcomes found post such actions which emerge within the macro-economy and the New York
securities markets (Patton, 2015).
INTERRELATIONSHIPS
In each currency war described, the Federal Government employed fiscal policy of Government spending
(Lewis, 2009) and monetary policy of currency devaluation to influence growth in Gross National Product (GNP)
and employment. Okun’s Law, which posits that employment growth is correlated directly with growth in GNP, was
incorporated into Federal law and adopted as a policy principle by the Federal Reserve (Thornton, 2012). Using
classical economic theory (Hill, 2014), Government spending increases one of the four factors making up GNP and
linearly increase GNP. Similarly, devaluing the dollar leads to more exports and less imports, which increases GNP
in a linear manner.
In each currency war period explored, the growth expected in US GNP has been less than forecast by
economists (Rickards, 2011). From 1929-1938, the US suffered a reduction in GNP of approximately 30%, an
unemployment rate averaging 18.2% while seeing net exports increase from 5-10% as a percentage of total GNP and
Government spending increase as an outcome of the Roosevelt New Deal (Samuelson, 2014). Deflation occurred in
the US prices during most of the 1930s. Although the US benefitted from devaluation of the floating dollar and
increased the use of Foreign Direct Investment (FDI) in the 1970s, GNP averaged 1.75% during a period in history
known as stagflation as unemployment rose to 7.5% (Bureau of Labor Statistics, 2013). A period that expected
export-driven growth in GNP and low unemployment experienced exactly the opposite (Rickards, 2011). Partly due
to continued devaluation of the dollar since 2008 and the implementation of the Federal Reserve quantitative easing
program, net exports have increased. However, growth in GNP has remained about 2.0% average and
unemployment has remained stubbornly over 6 percent for 6 years while the US work participation rate declined
from 67% to under 63% in December, 2014 (Bureau of Economic Analysis, 2014). For example, Dent (2014) has
demonstrated that the GNP time series corresponds closely to demographic time lines representing volumes of births
and family formations.
Assuming that the macroeconomic actions of fiscal and monetary policy by the Federal Government
(Government) during the security wars emanate from a system enables exploration of unexpected outcomes as the
result of behavior in another system (Taleb, 2012; Rickards, 2014). Incorporating complexity theory enabled the
author to make sense of the unintended consequences observed in both the New York securities markets and in GNP
of the United States (Patton, 2015). Viewing the macro-economy as a dynamic, adaptive system suggests that it is
too simple to expect a single action from one system (Federal government and/or the Federal Reserve) to direct a
predetermined outcome in another system (macro-economy of GNP and/or US employment) as demonstrated by
Taleb (2012).
The US economy is a system nested in a larger global economy, which itself is comprised of the set of
other national economies and Governments (Hill, 2014). Thus the actions of the US Government and/or Federal
Reserve do not occur in a vacuum (Rickards, 2014). In the 1930s, Germany, France and England each took turns
taking actions to position favorably exports and to counteract the steps taken by the US Government. During the
1970s, countries in the European Union (EU) and Japan were major players along with the US in the currency war.
Further, the OPEC oil cartel raised prices of petroleum to counteract the rising US inflation while increasing the
volume of oil sent to Japan, the EU and the US. The national players in the present currency war are the Chinese led
bloc (the Yuan), the euro portion of the EU and United States. Each player has taken steps to maintain the relative
value of its currencies within a range, thus diminishing the impact of the dollar-led devaluation occurring (Rickards,
2014).
Classical financial theory posits that the equity securities market, which is measured using the Standard and
Poor market index (the index), will correlate positively with the US economy measured by GNP (Rickards, 2014).
In the currency war of the 1930s, the index as expected remained basically flat mirroring economic activity
measured by the GNP. While growth in GNP averages only 1.75% in the period 1968-1980, the index did grow
from 103.1 to 107.9, an average growth of 5%. In the latest currency war beginning in 2008, a paltry growth rate of
about 2% in GNP has been accompanied by growth in the index of over 100% (938 to 2058 Standard and Poor
index). Incorporating systems theory and complexity theory into one’s thinking in reviewing these outcomes allows
the analyst to make sense of the unexpected outcomes by recognition that outcomes in a system are unpredictable
when exploring the relationship to inputs only considering a linear relationship (Patton, 2015).
CONCLUSIONS
The primary concepts evolving from complexity theory posit that the interrelationships among systems
influence the emergence of patterns that are highly unpredictable (uncertain) and which result from adaptation to the
environment present by independent, interacting agents functioning within the phenomena (Taleb, 2007). The
outcome of adaptation and emergence can be highly unpredictable turbulence and coherence of systems’ agents and
within the interacting systems themselves (Patton, 2015). Adaptation is defined by Gleick (1987) as “changing the
rules of the game” while one is functioning as an agent.
Applying complexity theory enabled the researcher to make sense about the outcomes emerging in
securities markets and in the macro economy during each of the three currency wars, during which actions by the
Federal Government and its agent the Federal Reserve suggested that outcomes observed should be orderly growth
in GNP and employment in the US (Rickards, 2014). There are observed changes which occurred in GNP and level
of employment/ unemployment during the time that the dollar was being purposefully devalued and Government
spending increased; however no specific pattern or relationship between the variables in the respective systems
emerged (Rickards, 2014). My interpretation about the reasons for these unexpected outcomes occurring in each of
the three currency wars is that one is observing complex systems in action,
Similarly, one makes sense from observations of unexpected outcomes emanating from the New York
securities markets as compared to outcomes flowing from the US macro-economy during the three studied currency
wars. Exploring the outcomes by applying complexity theory suggests that what is being observed are the
emergence of non-linear patterns which are the result of interactions between independent, adaptive agents (Taleb,
2012).
That currency wars will occur again appears likely due to development of global financial networks and the
motivation of countries to advance one’s own economic position at the expense of trading partners (Rickards, 2014;
Taleb, 2012). While advancing of volume of goods and services (GNP) are not predictable, Governmental actions
appear to influence a cycle of inflation or deflation within the macro economy (Rickards, 2011). Adopting a
framework of complexity theory enables the exploration of risk of securities market and macroeconomic market
collapse during a time of financial currency war. Further each national market is nested in the global security
markets, which implies the maximum value of a market collapse in either the bond or stock markets is a non-linear,
exponential function of a scale that will dwarf the collapse that happened during the 1930s (Dent, 2014). A
maximum collapse in any markets is unlikely and unpredictable; however a principle within the theory of
complexity is that collapse of a system will occur at some point in time (Patton, 2015).
Given the unpredictability of events, which can vary in scale of value as well, emerging in interrelated
systems, the individual long-term investor can’t plan with certainty about investments’ performance in the future.
Dent (2014) prescribes maintaining a diverse portfolio that includes securities –high-grade corporate bonds and
equity stock – and quality real estate. Ramsey (2014) suggests the use of Mutual and ETF funds to enact further
diversity in holdings. Dent (2014), Rickards (2014) and Ramsey (2014) recommend that each investor have a goal to
reduce one’s debt liabilities to zero as quickly as is feasible.
(Wind up with use of contingency theory)
REFERENCES